In Lockhart v Holden [2008] QSC 257, Justice Douglas of the Supreme Court of Queensland handed down a judgment where the franchisee challenged the franchisor's refusal to consent to a transfer of its franchise to a third party buyer.
Section 20(2) of the Franchising Code of Conduct (Code) provides that a franchisor must not unreasonably withhold a consent to the transfer of a franchise. In turn, section 20(3)(a) to (h) provides a non-exhaustive list of circumstances in which it is reasonable for a franchisor to withhold consent, including:
- 'The proposed transferee has not met the selection criteria of the franchisor.
- Agreement to the transfer will have a significantly adverse effect on the franchise system.'
A contravention of the Code results in an infringement of the provisions of the Trade Practices Act 1974 (Cth) (TPA) pursuant to section 51AD.
Such a contravention enlivens a right to damages under section 82 in favour of a person who suffers loss or damage by conduct of another person done in contravention of Part IVB of the TPA, which contains section 51AD.
There is little authority on the proper interpretation of section 51AD of the TPA and clause 20, in particular 20(3) of the Code. The decision of Justice Douglas in Lockhart v Holden sheds welcome light on how the particular provision of the Code read with section 51AD of the TPA should be interpreted.
FACTS
The franchisee operated a Holden motor vehicle dealership franchise through various associated parties since 1989 under franchise from Holden.
In 2003, the franchisee entered into Heads of Agreement with Zupps, a multi-unit and multibrand motor vehicle dealership franchisee, in terms of which Zupps was to buy the franchisee's Holden franchise and to lease the land from which the franchise was conducted from an associate of the franchisee.
As required by clause 20(1) of the Code, the franchisee requested the franchisor's consent to transfer its franchise to Zupps. In a letter of 22 July 2003 which was subsequently followed by further letters elaborating and explaining the franchisor's reasons for refusing consent, the franchisor confirmed that in its opinion, the proposed transfer would have a significant adverse effect on the franchise (system) in the following ways:
- It will increase the franchisor's risk exposure by concentrating a large portion of its business and distribution in the hands of one franchisee (Zupps).
- It may adversely impact on the ability of other franchisees in the region in respect of access to markets and the supply of products.
- The future business model of Zupps has additional risks within the ownership and management structure that are considered to have the potential to increase the franchisor's risks within its distribution network.
It was clear from the evidence before the Court that the franchisor's 'chain dealer policy' substantially influenced its grounds for refusal. Evidence of a longstanding chain dealer policy as accepted by Justice Douglas included:
- Ideally, each franchised outlet should be owned and operated by someone who has no interest in another business entity franchised by the franchisor.
- Reliance is placed upon the personal qualifications of the individuals named in the franchise agreement who have and exercise full managerial authority in the ownership and operation of the franchise.
- It is desirable that franchises be operated by individuals who own them or have a controlling financial interest in the operation.
- Where an exception is made, the individual operator relied upon in the agreement should be in a position to give the majority of his time and attention to each dealership.
- Where an individual or group owns any financial interest in an existing franchisor-granted franchise, it is considered that a chain of franchisees has been formed.
- The location of franchise outlets operated by a chain of franchisees should be carefully considered in an attempt not to deprive other franchises of the benefits of competition between franchisees.
- In a multiple dealer area, a chain of franchisees should ideally not hold more than 20–25% of the franchisor's vehicle sales for that area. Importantly, on the evidence before the Court, had the transfer to Zupps been approved, Zupps would have had 31.21% of the total new Holden vehicle sales in the area.
Justice Douglas was called upon to decide whether reliance on the grounds for refusal raised by the franchisor, particularly in view of its proven and known policies, was reasonable within the context of clauses 20(2) and 20(3) of the Code. There was a fundamental difference in approach between franchisor and franchisee in relation to the grounds a franchisor can rely upon to refuse a transfer. The franchisor argued that it can rely on its immediate and long term business interest and strategies in addition to the interest of other franchisees and the franchise system. To the contrary, the franchisee argued that the franchisor can only act reasonably if it considers those factors relevant to the selling franchisee, the potential buyer and the potential buyer's ability to comply with the provisions of the franchise agreement.
DECISION
Importantly, Justice Douglas held that the onus lay on the franchisee to establish that refusal by the franchisor to give consent to the transfer was unreasonable. The finding is significant because if the franchisee fails to prove that the franchisor wrongly relied on the reasons advanced for the refusal or acted in bad faith, the franchisor will be deemed to have acted reasonably.
Also critical was Justice Douglas' reliance on the only other Australian decision, Masterclass Enterprises Pty Ltd v Bedshed Franchisors (WA) Pty Ltd [2008] WASC 67, which supported the view that the circumstances in which it is reasonable for a franchisor to withhold consent are not limited to those described in clause 20(3) of the Code. The grounds for refusal set out in clause 20(3) of the Code are merely examples of when refusal will be considered reasonable but do not constitute an exhaustive list of grounds upon which a franchisor can reasonably withhold consent.
On this basis, Justice Douglas held and agreed with the decision in Masterclass that if a franchisor, in refusing consent, was acting in the legitimate interest of the continuing success of the franchise system in the long term, it cannot generally be considered to be unreasonable.
The franchisee attempted to convince Justice Douglas that it was impermissible for a franchisor to make a decision based on the effects a transfer may have on its interest as a franchisor because of what were said to be limitations in the language used. For example, section 20(3)(d) provides that consent can be reasonably withheld where the proposed transfer will have a significantly adverse effect on the franchise system. This, the franchisee argued, required the franchisor to focus only on the effects on the system rather than on the franchisor or the effects on other franchisees. In support, the franchisee argued that the purpose of the Code and the TPA was to redress the imbalance in market power between franchisors and franchisees. Justice Douglas had no difficulty rejecting the franchisee's argument primarily because the grounds listed in section 20(3) are not exhaustive, but merely examples of when withholding consent will be reasonable.
Justice Douglas endorsed the Masterclass approach and other decisions in similar context where the importance of a franchisor's confidence in a proposed franchisee's ability to operate within a continuing commercial relationship has been emphasised.
His Honour was careful to distinguish between what constitutes reasonable withholding of consent in a landlord/tenant relationship from a franchisor/franchisee relationship. His Honour emphasised the continuing close commercial arrangements between the parties to a franchise agreement which is absent in a landlord/tenant relationship. In doing so, His Honour also relied on the decision of Justice Carlson of the United States Bankruptcy Court in Re Van Ness Auto Plaza, Inc 120 B.R. 545, 548–549 (1990). On substantially similar facts, Justice Carlsen decided that continuing close commercial arrangements between parties to a franchise agreement are critical to determine reasonableness of withholding consent. Justice Carlsen noted that it is more difficult to determine whether an automobile dealer will be a suitable franchisee than it is to determine whether a lessee will perform under a lease. A lessee's major contractual duty is to pay rent timely, while a franchisee's duties are much more complex. Further, Justice Carlsen held that a franchise agreement involves the franchisor and franchisee in a much closer business relationship than commonly exists between a lessor and lessee. Accordingly, courts must be somewhat cautious in requiring a franchisor to enter into a franchise relationship involuntarily.
Justice Douglas concluded that although focus on the individual qualities of the proposed new franchisee cannot be excluded, other important considerations include whether a proposed new franchisee fits into the franchisor's overall network.
In the circumstances, His Honour was satisfied that the reasons advanced by the franchisor were reasonable, genuine and not in bad faith. Accordingly, the franchisee failed to prove that the franchisor unreasonably withheld consent.
Although not necessary to decide, Justice Douglas also held that a party related to the franchisee who owned the land from which the franchise business was operated would be entitled to claim damages under section 82(1) of the TPA where the damage is caused by the franchisor's contravention of a relevant provision of the TPA.
LESSONS
When considering whether withholding consent to a transfer is reasonable, a court will assess the reasons advanced by the franchisor against the special nature of the relationship between the franchisor and its franchisees or potential franchisees.
A court will accept reliance on the franchisor's policies and future franchise development plans. It is necessary to caution that in this instance the franchisor's policies and plans were well documented and known. Accordingly, a franchisor attempting to rely on an overall system of policies and future development plans will have to ensure that those are documented and known to franchisees.
The ability of a potential buyer to comply with its obligations under the franchise agreement is only one of the factors a court will consider.
In this case, it was common ground that Zupps is a highly respected franchisee but this was outweighed by the franchisor's broader policy considerations.
Franchisees intending to sell their franchises will be well advised to familiarise themselves with the franchisor's policies and selection criteria.
Franchisors will also be well advised to document their policies, future plans and selection criteria and apply those objectively and in good faith when considering a franchisee request for consent to transfer of a franchise.
Whilst Justice Douglas clearly followed the likely approach to be adopted by Australian courts, it remains important to appreciate that the outcome will invariably depend upon the facts of each case.
DLA Phillips Fox can assist franchisors to ensure that franchise chain policies, system development plans and selection criteria are sufficiently documented, to support critical decisions.
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